This article is dedicated to those of you who took the time to ask
questions. I thought most of you could use the following information.
A reader asks: My mortgage come up for renewal in a couple of months.
I have been locked in a five year term at 9.25%. What term
should I choose this time? I am leaning towards short term (6 mos
or 1 year) since I got burned last time, locking in for 5 years.
Answer: Five years ago, nobody could have predicted that the rates
would have gone down the way they did. The fact they did could be
a blessing in disguise. First of all, you will find that the rate
differential between a 6 month term and a five year term is less that 1/2%
(5.95 vs 6.2%). The answer therefore is not so much rate related
but rather what you intend on doing with your residence over the next five
years. If you intend to live there, then I would lean towards the
sure bet, the 5 year term! It is unlikely that the economy can afford
to allow the rates to come down even further, however, it is most likely
that the rates will escalate over the next five years.
Whatever you decide to do, I feel it pertinent to add an extra piece
of advice...maintain your present mortgage payment at renewal. In
other words, don't allow the rate decrease to affect your payment.
Let's look at an example. Let us assume that your initial mortgage
was $100,000 at the 9.25% rate amortized over 25 years. For the last
five years you have been paying $845/month. You now owe $93,340.
Your present mortgage company will send you the renewal with payments calculate
on the remaining 20 years at a new low rate (hopefully 6.20%) with
payments of $675. Most Consumers will choose the option of saving
$170 per month (that's the old payment versus the new payment). If
you had chosen to keep your old payment ($845) at this reduced rate, you
would have shortened the amortization to 13 years instead of 20 years.
That would have saved you some $50,000 in interest over the remaining life
of your mortgage. Every time you receive your mortgage renewal, you
should re-analyse your cashflow with the single purpose in mind of paying
as high a payment as possible, in order to decrease the amortization to
as low as budgets will permit. In our example, keeping the same payment
as before the renewal, reduced the amortization by 7 years.
Another reader writes: My mortgage will allow for increased payments
every year, as well as lump sum deposits against the principal. Which
is better?
Answer: The sooner you prepay your mortgage, the better! Most
mortgage companies will allow a prepayment privilege by way of a lump sum
deposit against the principal during the year, knowing full well that you
probably will not exercise your option because you assume that you must
have it all or nothing. In other words, if your mortgage is $100,000
and your prepayment privilege is 10% pay down each year, one might construe
that you must have the $10,000 (that's 10% of $100,000 mortgage) before
you are allowed to prepay. That is simply not the case. Even
if you only had the equivalent of one extra month's payment each year,
that alone would reduce your overall amortization to 18 years from 25.
By the same token, most Consumers also have a clause in their mortgage
allowing for increased payments during the term. If the increase
payment potential is 10% of the old payment, most people think that they
must increase the full 10% or nothing. As in our situation above,
you may increase your payment by any amount up to the full 10% (15% in
some cases). As a matter of interest, an increase each year of only
5% of the old payment will decrease a 25 year mortgage down to 14 years.
That's a savings of almost 50% of the interest payable. My clients
have found it much easier to increase payments each year rather than trying
to save for a lump sum deposit against the principal.
A reader asks: I have been an avid reader of your column now for several
years. By the sounds of it, you can save everybody time and money.
Why doesn't everybody use the services of a mortgage broker rather than
going to their own Bank?
Answer: I guess it's out of sight , out of mind. The big institutional
lenders in this country have branch offices at nearly every street corner,
and their reputation from a Consumer's point of view is good. Most
Mortgage Brokers can indeed save their clients time and money, however,
the Broker cannot spend the amount of money necessary to advertise this
fact. Most Mortgage Brokers get their business from word of mouth
advertising originating from satisfied clients.